Information Asymmetry

Addis Ababa university

management of financial institutions

Group 4
• SABA SETEYE • YORDANOS BELETE
BEE /0242/11 BEE/3695/11
• YEMISRACH KETEMA • SARON ABERA
BEE /1971/11 BEE/8199/11
• YENENESH ALEMAYEHU • MEHUBA DAWED
BEE/2841/11 BEE/5837/11
• SEWASEW ABJEW • YIGREM ABERHAM
BEE /4719/11 BEE/0888/11
• NATNAEL • SAMRAWIT GETACHEW
WONDAFRASH BEE /0954/11
BEE/8918/11
• Zegeye Belay BEE/2985/09
Objectives
after the presentation we will be able to
• Understand asymmetric information
• Understand bank capital requirement
• Asymmetric information and banking regulation
• Restriction on asset holdings and bank capital
requirements
• Political economy of the savings and loan crisis
Asymmetric information
• Information asymmetry is a condition under which one business
party possesses more information than the other party they are
dealing with.

• One party’s access to more relevant and up-to-date information

can result in business imbalances and even exploitation
• In 2001, Joseph Stiglitz, George Akerlof, and Michael Spence
shared the Nobel Prize in Economics for their study of asymmetric
information in capital markets.

• Notably, Akerlof showed how the financial sector in developing

countries could be skewed when financial service providers—
armed with college degrees, deep networking, and privileged
information—exploited retail market participants who were not
nearly as informed or connected.
• The Nobel committee highlighted Akerlof’s 1970 essay, "The Market
for Lemons," as an invaluable study on the economics of
information.

• Akerlof's "lemons problem" used the secondhand car market to

describe how information asymmetry (with the seller

• Information asymmetry affects business transactions in three primary

ways, Adverse selection, Moral hazard, Monopoly of knowledge
Adverse selection
• describes circumstances in which either buyers or sellers have
information that the other group does not have.

• In these cases, when these two groups are informed to different

degrees, which creates asymmetric information
Moral Hazard

• Moral hazard is a situation in which a party is more likely to take

risks because the costs that could result will not be borne by the
party taking the risk.

• This problem with asymmetric information takes place after the

transaction
Monopoly of knowledge:
• Only a select few individuals are presented with the necessary
information to understand a situation and make decisions.

• Monopolies of knowledge can occur in government, where only

officials with security clearances can be informed of privileged
intelligence.
• In some businesses, only senior management receives full access to
company information provided by a third party, yet lower-level
employees may be called upon to make key decisions with only
limited information at their disposal.
Bank capital requirement
• A capital requirements( also known as regulatory capital
or capital adequecy) is the amount of capital a bank or
other financial institution has to have as required by its
regulator.
• Capital requirements are regulatory standards for banks that
determine how much liquid capital (easily sold assets) they must
keep on hand, concerning their overall holdings.

• Express as a ratio the capital requirements are based on the

weighted risk of the banks' different assets.

• after an economic recession, stock market crash, or another type of

financial crisis
• It is the amount of money a firm needs to pay for regular expense
and upcoming projects

• NBE planned to increase the minimum capital for banks to operate

to 2 billion Birr ($90 million) and instructed all commercial banks
to increase their capital to that amount by 2020

• It is standardize regulations in place for banks and other

depository.
Bank regulation
There are around eight major bank regulations
1. Government / Deposit insurance company
2. Restriction on asset holdings
3. Bank capital requirments
4. Bank supervisions chartering examination
5. Assessment of risk manangement
6 Disclosure requirement's

7 Consumer protections

8 Restrictions on competitions
Restriction on asset holdings and bank
capital requirements
• A restricted asset is a cash or another item of monetary
value that is set aside for particular purpose, primarily to
satisfy regulatory or contractual requirements.
• The government restricts bank to hold types of assets and
amount of each asset
• Bank are not allowed to hold corporate stocks and junk
bonds. Banks are discouraging to hold too much risky
loans
• The government restriction of bank asset holdings is intended to
reduce moral hazard of taking too much risk
Attempts to restrict financial institutions from too much risk taking
Bank regulations
• Promote diversification
• Prohibit holdings of common stock
Capital requirements
• Minimum leverage ratio (for banks)
• Basel accord: risk-based capital requirements
• Regulatory arbitrage
References
• Licensing and Supervision of Banking Business Minimum Capital
Requirement for Banks Directives No. SBB/50/2011
• https://
nbebank.com/wp-content/uploads/pdf/directives/bankingbusiness/sbb-50-11.p
df
• Articles 18(1) and 59(2) of Proclamation No. 592/2008,
• https
://www.slideshare.net/nino31/m21-mish1520-06ppwc20?qid=c45e845e-cf39-
4cc4-b02c-47a16c2f9041&v=&
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